| LONDON, July 30
LONDON, July 30 Major banks face growing
pressure to extract more money from, or even sever ties with,
unprofitable hedge fund clients as they cut costs in the face of
tough trading conditions and try to refocus on the biggest
Industry insiders say prime brokers - which provide services
such as stock lending and financing for hedge funds - are
sifting through their client lists, in some cases demanding
higher fees on trading or a greater share of a fund's business,
and sometimes telling funds to look elsewhere.
The moves come as banks, faced with a tough economic
environment, higher regulatory costs and looming Basel III
capital standards that are set to reduce returns on equity, look
to cut costs across the board and focus on more profitable
Small funds, most of which have found it a struggle to
attract client cash since the credit crisis, or funds with
little leverage or trading activity look less attractive to many
banks, although in the secretive $2.1 trillion industry few
executives are keen to reveal who has lost out.
Brokers are in many cases instead focusing on trying to
capture even a sliver of business from the biggest and most
active hedge fund traders, for instance Brevan Howard or Moore
Capital, who can deliver tens of millions of dollars in
commission to their main brokers.
"Prime brokers are absolutely trimming clients. They're
putting more and more focus on key clients. They've got less
manpower and physical resources," said one well-placed industry
source who asked not to be named.
"A number of prime brokers have told me the same story -
they're focusing on key accounts to increase their share of
wallet. If you grow from 4 percent to 10 percent of a big fund's
trading flow (then that's worth a lot). Goldman Sachs,
Morgan Stanley and UBS have all told me they're
All three banks declined to comment. A source close to
Morgan Stanley said: "There is no change in strategy within the
prime broking division and it maintains its focus on the same
mix of clients."
Earlier this year the Financial Times reported that a number
of top prime brokers were preparing to pass on increases to the
cost of funding to hedge fund clients.
Banks cutting hedge funds is not in itself a new phenomenon.
One hedge fund manager told Reuters they were asked to leave by
one major bank after the credit crisis because they traded
credit, which was less profitable for the broker than equities.
But industry executives say that the pace has picked up as
banks face up to higher costs.
"There's been an acceleration (in prime brokers culling
hedge fund clients). There's been a trend of cutting off dead
wood," said Dermot Butler, chairman of administrator Custom
House Group, which works with funds and prime brokers.
"Prime brokers can't afford to be generous at all. If
someone's not making money for them then they're not worth
having on the books... Some administrators and prime brokers are
sacking smaller funds but retaining big funds from the same
Hedge funds typically use three prime brokers, who make
money by lending money for trades or securities for
short-selling, arranging custody for a fund's assets or even by
finding office space or providing advice on regulation or risk
Brokers can often look for a fund firm to provide them with
at least $250,000 of business per year, said one hedge fund
executive, which would be a substantial amount for a manager
with, say, $25 million in assets.
"If you're a small fund with $100 million of AUM (assets
under management) and you have a strategy that's not hugely
leveraged, it may mean you're not paying the broker very much,"
said one prime broker who spoke on condition of anonymity.
"Some (clients) can be very high maintenance, they can be
calling your support teams twice a day."
The moves come as investors flock to the perceived safety of
the biggest hedge funds, making them even more lucrative for
prime brokers, particularly when clients are in general making
smaller trades than before the crisis.
Nearly 65 percent of the $2.1 trillion industry's assets are
with firms with more than $5 billion in assets, up from 58
percent three years ago, according to Hedge Fund Research.
In contrast, firms with less than $1 billion in assets
control just 11 percent of industry assets, down from 14 percent
three years ago.
"It's related to the idea that after 2008 not every fund was
going to grow rapidly. Today if you take 10 in and incubate them
for a while, a smaller number will grow rapidly," said David
Storrs, CEO of fund of funds Alternative Investment Group, who
said prime brokers are culling "low pedigree managers".
Banks can adopt a range of tactics with funds that are
taking up their time without delivering sufficient revenue.
Some may demand a greater share of a fund's trading
business, levy higher charges on trades or ask funds to post
more collateral, in a bid to extract more revenue.
If funds still don't provide enough revenue, then brokers
can also axe services such as capital introduction - introducing
them to their network of potential investors - in a bid to bring
"Some of the smaller firms we are talking to, they have much
more margin to equity than the larger firms, and they are not
able to segregate their assets from their prime brokers which
the larger guys are able to do," said one investor in hedge
funds who talks to both small and large managers.
"These things have only been getting worse this year in our